Maybe this is the year you’re ready to elevate your business game in the US. Your friends or advisors might have suggested forming an LLC or even setting up a corporation. Sounds impressive, right? But what’s the real difference between them? And how do you choose the right fit for your needs?
In the debate of LLC vs. corporation, the right option depends on your future goals. Let’s break down what each structure offers, how they differ, and how it could shape your business journey ahead.
What Is an LLC?
So, what is an LLC and how does it work exactly?
LLC or Limited Liability Company is one of the legal business structures in the United States. It’s a popular entity that combines the elements of two other business structures: partnerships and corporations.
This business structure separates your personal assets from your business liabilities while offering a flexible management structure. Your personal assets, like property or savings, are basically protected if your business ever faces legal troubles or debts.
How Does It Work?
When you start an LLC by filing an Articles of Organization with your state’s business registry, this document establishes your limited liability company as a legal entity. This entity can own property, enter into contracts, and be involved in legal matters in its own name.
Additionally, a filing fee—which varies by state—must be paid.
LLCs can be managed by the owner or members themselves or by appointed managers.
- If managed by members, they directly handle the daily operations of the business.
- If managed by managers, the members appoint one or more individuals to oversee the operations while they take a more passive role.
In practice, operating an LLC involves maintaining compliance with state laws and regulations, such as creating an operating agreement, paying ongoing fees, and filing annual reports. Moreover, LLC provides comfortability in terms of ownership. Individuals, other LLCs, or even foreign entities can be the members while there’s no limit on numbers.
While these tasks are relatively straightforward, they lay the groundwork for how your LLC will function and how decisions will be made.
What Is a Corporation?
Alright, let’s explore what a corporation is and how it functions.
A corporation is a distinct legal entity in the US that is made up of a group of individuals, mostly used for business purposes. The owners are often referred to as ‘shareholders’ in this structure—who are not personally liable for any kind of business debts or obligations.
We can say a corporation is like a distinct “person” that exists independently—in the eyes of the law—that owns the property, sues or is sued, enters contracts, is liable for debts, and is involved in lawsuits, just like an individual.
So, basically, a corporation is a distinct business entity that shields its owners from personal risk while having a clear structure for managing and running the business.
How Does It Work?
When you start a corporation by filing an Articles of Organization with your state’s business registry, you create a legal entity that can conduct business, enter contracts, and take on debt under its name.
In the matter of ownership, a corporation works by separating ownership from management and operating under a structured set of regulations.
- The ownership of a corporation is typically distributed in the form of shares of stock. There is minimal accountability for shareholders, who are the owners of these shares. This means that their personal assets are normally safeguarded from the debts and legal troubles that are associated with the organization.
- The management of a corporation is typically organized with a board of directors and corporate officers. Key decisions, such as setting up company policies and overseeing the larger objectives, are the responsibility of the board of directors, who are elected by the shareholders.
Whereas, among the officers, the CEO and CFO oversee daily operations and ensure the organization’s smooth functions.
Corporations must adhere to specific regulations, such as holding annual meetings, maintaining detailed records, filing taxes, and following state and federal laws.
Now that you have a basic understanding of how LLCs and corporations work, let’s learn how these two structures are formed in the US.
How to Form an LLC?
To form an LLC, you must submit a legal document, known as the “article of organization,” to the secretary of state in the state where the LLC will operate. This document contains the fundamental information regarding your LLC, including its name, address, and members.
Although not necessary in all states, drafting an LLC operating agreement is strongly advised. This agreement specifies the management procedures for your LLC as well as the allocation and transferability of ownership interests. It ought to cover the consequences of a member quitting the LLC as well.
In the absence of this agreement, several states may mandate that the LLC dissolve upon the departure of a member.
How to Form a Corporation?
You must submit articles of incorporation to your state’s secretary in order to form a corporation. This document is like an LLC’s articles of organization, and both documents contain essential information about your business. Nevertheless, there are additional procedures attached to the establishment of a corporation.
You will be required to establish and implement corporate bylaws, which delineate the regulations for the corporation’s operations. Additionally, you will be allowed to elect a board of directors who will be responsible for the corporation’s operations and the formulation of significant decisions.
Furthermore, you will issue stock to shareholders, which is a feature that may appeal to experienced investors—because of how simple it is to transfer shares and how the company may carry on even in the event that a shareholder departs.
If you’re exploring which structure fits best for your business needs, you might find our detailed guides on how to form an LLC and how to form a corporation particularly useful for a deeper dive into each process.
Key Differences: LLC vs. Corp
Now that you have an idea of how to start a corporation and an LLC, let’s dig into the distinctions between these two. Start with the benefits and drawbacks:
LLC vs. Corporation: Pros and Cons
LC Pros
- Flexible Management: Running an LLC gives you options. You can manage it yourself or bring in others to handle things, depending on what suits your needs.
- Pass-Through Taxation: LLCs are great for tax simplicity. The company itself doesn’t pay taxes. Instead, profits and losses go right onto your personal tax return, making things a bit easier.
- Fewer Formalities: LLCs are lighter on rules and paperwork. There are fewer meetings and less red tape, which means less time dealing with administrative stuff.
LLC Cons
- Limited Lifespan: In some places, an LLC might have to dissolve if a member leaves or passes away unless you’ve set up an agreement that says otherwise.
- Self-Employment Taxes: As an LLC member, you’re considered self-employed and will pay self-employment taxes on your share of the profits. This can be pricier compared to regular employment taxes.
Corporation Pros
- Strong Liability Protection: Corporations keep their personal assets safe. The business’s debts and legal issues stay separate from your personal finances.
- Perpetual Existence: Corporations can go on forever, even if shareholders leave or pass away. This makes them stable and reliable for long-term plans.
- Investor-Friendly: If you’re looking to bring in investors, corporations can issue stock, which makes raising funds and expanding easier.
Corporation Cons
- Double Taxation: One of the key drawbacks is that corporations face double taxation—first on the company’s profits and then again on dividends paid to shareholders.
- More Formalities: Corporations come with more rules and formalities. You’ll need to hold regular meetings, maintain detailed records, and follow a structured management system with a board of directors.
Other Key Differences
- Management Structure: LLCs offer flexible management options, while corporations have a more structured setup with a board of directors and officers.
- Ownership and Transfer: Selling shares in a corporation is typically a simpler way to transfer ownership, but doing so in an LLC may need additional steps.
- Taxation: The main tax difference between LLCs and corporations is their default tax treatment. Corporations generally face double taxation unless they elect S Corporation status, which has specific requirements.
LLCs usually benefit from pass-through taxation, making tax handling simpler but potentially higher due to self-employment taxes. LLCs also have the flexibility to choose C Corporation or S Corporation taxation if it better suits their needs.
These differences highlight the unique advantages and challenges of each business structure. Whether you value flexibility and simplicity or prefer a more formal, structured approach with easier access to investors, understanding these factors can guide you in choosing between an LLC and a corporation for your business.
How LLCs Are Taxed in the US?
For federal income tax purposes, LLCs are typically treated as pass-through entities. This suggests that the corporation does not pay any federal taxes. Rather, the owners receive the profits and losses straight and record them on their individual tax returns.
Pass-through taxation is not always the greatest choice, though. Due to the existing 15.3% self-employment tax, LLC owners may have larger tax obligations. The impact of this can vary depending on the availability of deductions and exemptions, as well as whether the corporate or personal tax rates are comparatively higher.
A multi-member LLC is treated like a partnership, while a single-member LLC is taxed like a sole proprietorship overall. Filing Form 8832 with the IRS lets you choose to have your LLC taxed as a company if this setup does not work for you. And if your LLC fits, you can choose to be taxed under Subchapter C or even Subchapter S.
How Corporations Are Taxed in the US
Corporations can be taxed in one of two ways:
- C Corporations: These are taxed under Subchapter C of the Internal Revenue Code and are subject to double taxation. The corporation pays taxes on its profits, and then any dividends paid to shareholders are taxed again on their personal tax returns.
- S Corporations: These are taxed under Subchapter S and avoid double taxation. Instead, profits pass through to shareholders’ personal tax returns, where they are taxed once. However, not all corporations qualify as S corporations. To become an S Corp, there are specific requirements: no more than 100 shareholders, only one class of stock, and shareholders must be U.S. citizens or residents, or certain estates and trusts.
Which Structure Should I Choose?
Choosing between an LLC and a corporation can feel overwhelming, but understanding your goals can make the decision easier.
If you want a simpler setup with fewer formalities and pass-through taxation, go with an LLC. It’s a great option if you’re not looking to attract investors or deal with a lot of red tape. An LLC gives you flexibility in how the business is run and how profits are shared.
On the other hand, a corporation might be the better choice if you plan to seek investors, sell ownership stakes, or even take your company public someday. Corporations are designed for more complex ownership structures and can be more attractive to investors because they can issue stock.
Ultimately, it’s a good idea to talk to a certified public accountant, a business attorney, or an expert. They can help you to clear the details and choose the structure that best fits your business goals and needs.
FAQs on LLC vs. C Corp
Q1: Can a C Corp tax be applied to my LLC?
Answer: If an LLC’s tax status allows it, it may elect to be taxed as a C Corp to the IRS by submitting Form 8832.
Q2: Can non-residents own an LLC in the U.S.?
Answer: Yes, there are no restrictions on their ownership. Non-residents can own an LLC in the US.
Q3: What’s the main advantage of choosing a C Corp over an LLC?
Answer: A C Corp is often preferred for its ability to raise capital through stock and its structure, which can be appealing to investors.
Q4: Do non-residents face double taxation with a C Corp?
Answer: Yes, non-residents, like all shareholders, face double taxation with a C Corp, as both the corporation and dividends are taxed.
Q5: Do LLCs have the same tax flexibility as C Corps?
Answer: LLCs have more flexibility in tax treatment by default, as they are usually taxed as pass-through entities but can opt for C Corp taxation if it suits their needs.
Conclusion
In summary, creating an LLC is sometimes less complicated and allows for greater management freedom, whereas creating a corporation requires additional formalities but has certain benefits, especially when it comes to luring investors. Consider the pros and cons of each structure carefully as they vary.
Furthermore, consultation with a financial advisor or business legal experts can provide you with personalized perspectives on the concept of LLC vs. corporation to determine the most compatible business structure with your objectives.
